There is a misperception that the “high” interest rates of microfinance gouge the recipients. To the contrary, borrowers benefit significantly despite “high” interest rates.
Why? Returns on investment for microenterprises are extremely high. Studies—including those by my own organization—have estimated returns from microenterprises fall in the range of 50% to 100%. When a borrower is earning such high returns, paying interest rates in the range of 26% (what SKS charges), or even higher, is perfectly acceptable to a borrower.
Such high returns exist in microenterprises because microentrepreneurs in the developing world run businesses (1) that primarily use family labor, which is more productive than hiring outsiders, (2) that have low infrastructure costs (e.g., village groceries are often home-front stores), (3) that are in the informal sector so there are no taxes and legal costs, and (4) where financial capital is a small percentage of the overall inputs, which are primarily labor. This results in extraordinarily high returns for microenterprises.
As to why microfinance institutions need to charge such “high” interest rates: They have to cover the transactions cost of lending to the poor. It is much more expensive to make a large number of tiny loans than to make a small number of larger loans. In addition, microfinance institutions often have to provide doorstep service—with loan officers traveling to remote villages to give loans and collect repayment. That’s much costlier than setting up a branch office.
Of course, as with any sector, there are the occasional instances where microfinance institutions take advantage of near-monopoly situations and charge interest rates almost as high as loan sharks—50% to 100%. This is not ideal. But capping interest rates is not the best way to solve that problem. Instead, we should stimulate competition so that the existing microfinance providers must lower rates in order to survive.
Microfinance services can certainly help the poor when priced fairly. When institutions set interest rates to cover efficient delivery costs, the result is win-win—long-term, sustainable financial services that generate a positive impact on the poor.
But every additional dollar of excess profit investors generate for themselves through high—and often deceptive—pricing comes directly from the pockets of the poorest members of our society, leaving the poor still poor while the wealthy become wealthier.
Pricing products at a fair level does not always happen when those setting the price are in a position to receive personal gain through high pricing. As microfinance moves from the nonprofit into the for-profit world, we are seeing more institutions that want aggressive profits. Sustainable pricing is mutually beneficial; however, as shown in the story (BusinessWeek, 12/13/07), some institutions have gone too far.
Sadly, we have reached a point at which some microfinance institutions are blurring the line between constructive microfinance and exploitative money lending. Over the past 25 years we have successfully learned how to get financial services to the poor at an affordable price, but now those lessons are being applied and distorted by institutions with different values and goals.
We in the microfinance industry must continue our plans to build a vibrant market of microfinance services by setting fair pricing and profit levels, and holding one another accountable to these standards. We must build consumer protection programs to shield the poor—from ourselves. We must adhere to and defend the original principles of microfinance, and not allow people interested in personal or corporate gain to destroy what we have taken decades to build.
Ironically, the first pawn shops were started by churches to assist their parishioners. Pawn shops then went in a different direction. We must act now so that microfinance does not follow the same path.Opinions and conclusions expressed in the BusinessWeek.com Debate Room do not necessarily reflect the views of BusinessWeek, BusinessWeek.com, or The McGraw-Hill Companies.
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